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The  Federal  Income  Tax 

IN  ITS  RELATION  TO 

Life  Insurance  Companies 

BY 

Kossuth  Kent  Kennan 

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BURDICK  &  AM  .FN.  Printers 

MILWAUKEE 

1913 

1S£. 

THE  FEDERAL  INCOME  TAX 


IN  ITS  RELATION  TO 


LIFE  INSURANCE  COMPANIES. 


In  the  debates  upon  the  proposed  income  tax  law 
which  took  place  in  the  House  of  Representatives  on 
the  sixth  and  seventh  days  of  this  month  (May,  1913) 
the  points  most  discussed  were  not,  as  might  have  been 
expected,  the  advisability  of  an  income  tax  nor  the 
general  scheme  of  rates  and  deductions.  The  one 
question  upon  which  there  seemed  to  be  the  most  diver- 
gence of  opinion  and  which  received  more  attention 
in  the  debates  than  any  other  was  the  effect  of  the  law 
upon  mutual  life  insurance  companies.  The  question 
is  important  as  there  are  some  6,000,000  policy-holders 
in  such  companies  who  would  be  directly  affected  by 
any  tax  upon  the  corporate  income.  A  large  number 
of  petitions,  letters  and  memorials  in  favor  of  the  en- 
tire exemption  of  mutual  life  insurance  companies 
were  presented.  The  chief  argument  advanced  in 
favor  of  such  exemption  was  that  mutual  life  insur- 
ance companies  should  be  placed  in  the  same  category 


284562 


as  mutual  savings  banks  and  fraternal  insurance  com- 
panies which  are  exempted.  The  answer  to  this  was 
that  the  mutual  companies  made  large  profits  which 
should  be  treated  as  income  and  that  the  corporation 
tax  law,  which  is  now  practically  merged  in  the  federal 
income  tax  law,  had  provided  for  a  tax  on  such  profits. 
The  contention  in  favor  of  total  exemption  did  not  ap- 
peal to  the  majority  of  the  House,  but  there  was  an- 
other question  which  gave  rise  to  a  great  deal  of  ani- 
mated discussion  and  is  likely  to  be  a  subject  of  con- 
troversy when  the  bill  reaches  the  Senate,  viz : 

ARE  POLICY  DIVIDENDS   INCOME? 

The  varying  views  which  arose  as  to  whether  the 
so-called  dividends  returned  to  policyholders  by 
mutual  life  insurance  companies  should  be  treated  as 
a  deduction  from  gross  income  may  be  classified  un- 
der three  heads : 

1st.  That  such  "dividends"  should  be  deducted 
on  the  ground  that  they  were  simply  returns  of  over- 
charges. 

2nd.  That  the  whole  of  the  dividends  paid  to 
policyholders  should  be  included  in  income,  on  the 
ground  that  they  represent  profits. 

3rd.  That  so  much  of  the  dividends  as  repre- 
sented return  of  premium  payment  should  be  deducted ; 
but  so  much  as  represented  net  earnings  or  profit 
should  be  taxed. 

The  first  and  second  contentions  are  clearly  unten- 

2 


able,  as  the  following  analysis  of  the  account  with  an 
ordinary  policy  in  a  mutual  life  company  will  show : 

Age  38,  20  Payment  Life,  $2,500,  issued  1904.  Gross  premium 
$100.85,  Net  premium  $79.35,  Loading  $21.50.  American  Ex- 
perience Mortality  Table  with  3%  interest.  Illustration  of 
Dividend  Account  at  end  of  9th  year,  in  1913. 

Dr. 

To  Loading $  21.50 

"    Mortality,  as  per  table 21.95 

"    Reserve,  9th  terminal   602.08 

"    Dividend    24.28 

$669.81 

Cr. 

By  Reserve  8th  terminal $526.50 

''  9th  premium  paid  100.85 

"  Interest  on  Reserve  3% 18.18 

"  Salvage  on  Loading  8.89 

"  Salvage  on  Mortality,  24%   5.28 

"  Snrplns  interest  on  reserve  1.6% 9.70 

"  Interest  on  Loading  salvage  4.6%    .41 

$669.81 

It  will  be  seen  from  the  above  (w^hich  is  an  actual, 
not  an  assumed  case)  that  the  last  four  items  on  the 
credit  side  exactly  equal  the  amount  of  the  dividend 
on  the  debit  side  and  constitute  the  elements  of  which 
it  is  composed.  If  we  consider  these  elements  separ- 
ately it  will  appear  that : 

1st.  Salvage  on  loading  (for  expenses)  is  not  earn- 
ings or  profit,  but  simply  a  return  of  principal  or 
capital.  The  company,  out  of  abundant  caution,  re- 
quired the  payment  of  a  larger  premium  than  was 
necessary,  it  being  understood,  however,  that  if  the 
expenses  proved  less  than  had  been  estimated  then  the 
surplus  would  be  returned.    This  is  not  income  to  the 

3 


compan}^  because  it  is  refunded.  It  is  not  income  to 
the  policyholder  because  (although  wrongly  termed  a 
dividend)  it  is  a  mere  refund  of  money  temporarily 
advanced  by  him  to  the  company. 

If  the  policyholder  were  permitted  to  deduct  the 
amount  of  premium  paid  on  his  life  insurance  in  the 
first  instance  as  a  legitimate  business  expense,  then  of 
course,  in  the  administration  of  the  income  tax,  it 
would  be  necessary  to  treat  this  refund  as  income  to 
him.  Although  it  is  called  a  ''salvage"  it  is,  strictly 
speaking,  not  an  amount  saved.  To  illustrate :  A  man 
making  a  trip  to  New  York  might  provide  himself 
with  $100  for  traveling  expenses  and  upon  his  return 
find  that  he  had  spent  only  $75.  It  does  not  follow 
that  he  has  saved  $25.  He  did  not  expect  tO'  spend 
$100  and  only  took  the  extra  $25  to  provide  for  emer- 
gencies. In  like  manner  it  might  be  said  that  the 
mutual  insurance  company  did  not  expect  to  spend  the 
whole  amount  of  the  premium  required.  It  "loaded" 
it  enough  to  provide  for  any  extraordinary  expenses 
which  might  occur  and  then  returned  the  amount  not 
used. 

2nd.  "Salvage  on  Mortality''  is  not  profit  or 
earnings  if  refunded  to  the  policyholder  and  should 
not  therefore  be  treated  as  income.  The  insurance 
companies  very  wisely  provide  for  a  heavier  mortality 
than  actually  occurs.  It  is  realized  that  war,  pestilence, 
floods,  earthquakes  or  other  far-reaching  catastro- 
phies  might  at  any  time  produce  an  excessive  mortality 
which  the  company  must  be  prepared  to  meet.  But 
when  the  year  has  ended  and  it  is  found  that  the  num- 
ber of  deaths  has  actually  been  less  than  the  mortality 
tables  provide  for,  then  there  is  a  considerable  sum  of 


over-paid  premium  which,  in  the  case  of  a  mutual 
company,  can  be  safely  refunded  to  the  policyholder. 
The  premiums  which  grant  the  insured  participation 
in  the  profits,  are  always  loaded,  the  'loading" 
amounting  usually  to  a  fixed  percentage  of  the  net 
premium. 

3rd.  Surplus  interest  on  reserve.  The  ''terminal 
reserve"  is  defined  by  the  Wisconsin  law  as  the  "re- 
serve at  the  end  of  the  policy  year,  and  is  the  sum 
sufficient,  with  the  premiums  coming  due,  to  provide 
for  the  future  expense  and  mortality  charges  and  ma- 
ture the  policy  according  to  its  terms,  all  computed 
upon  the  expense  charges  assumed,  the  table  of  mor- 
tality adopted  and  the  rate  of  interest  assumed."  The 
interest  required  on  the  reserve  in  Wisconsin  is  3%; 
but  in  the  case  of  the  policy  mentioned  above  as  an 
example  the  interest  actually  earned  was  4.6%  so  that, 
at  this  point,  we  reach  something  which  is  clearly  earn- 
ings, profit,  or  income  and  should  be  taxed  as  such 
Vv'hether  it  is  retained  by  the  company,  or  in  the  case 
given,  is  returned  to  the  policyholder.  As  a  matter 
of  convenience  it  is  much  simpler  and  easier  to  collect 
the  tax  on  the  aggregate  sum  in  the  hands  of  the  com- 
pany than  to  follow^  it  into  the  hands  of  the  policy- 
holders. In  the  policy  account  given  above,  moneys 
which  have  been  paid  in  by  the  person  insured  and  used 
as  reserve  have  earned  more  than  was  needed  for  pur- 
poses of  insurance  and  the  surplus  earning  is  refunded. 

4th.  Interest  on  loading  salvage.  As  in  the  last 
case  above  this  amount  is  clearly  income.  In  the  ex- 
ample given  the  policyholder  practically  loaned  the 
company  $8.89  for  one  year  at  4.6  per  cent  and  re- 
ceived the  amount  back  with  41  cents  interest. 

5 


The  example  above  illustrates  the  important  princi- 
ple so  often  overlooked  in  the  discussion  of  this  sub- 
ject, that  capital  utilized  in  insurance  may  at  the  same 
time  be  employed  in  the  production  of  wealth.  It  is 
often  claimed  that  premiums  paid  for  life  insurance 
are  not  an  investment,  but  that  statement  is  clearly  in- 
correct in  the  case  of  participating  policies. 

It  may  be,  and  usually  is  true  that  the  primary  ob- 
ject of  insurance  is  provision  for  the  future;  but  this 
involves  certain  forms  of  investment  which  almost  in- 
variably yield  more  income  than  is  absolutely  needed 
for  insurance  purposes.  In  the  example  given  above 
the  policyholder  paid  a  premium  of  $100.85,  of  which 
sum  it  was  found  that  $14.17  was  not  needed  and  it 
was  therefore  returned.  There  were  also  surplus  in- 
terest earnings  to  the  amount  of  $10.11  which  were 
not  required  and  were  therefore  paid  over  to  the 
policyholder. 

In  the  case  of  a  stock  company  with  non-participat- 
ing policies,  there  would  be  no  refund  and  the  surplus 
interest  earnings  would  be  applied  to  dividends  on  the 
stock  and  increase  of  reserves  and  surplus. 

EFFECT  OF  THE  TAX  ON  THE  POLICYHOLDER 

It  is  estimated  that  the  average  life  insurance  policy 
is  for  an  amount  between  $2,000  and  $2,500,  and  the 
example  given  above  refers  to  a  $2,500  policy  with 
earnings  perhaps  a  little  greater  than  the  average.  The 
effect  of  the  proposed  income  tax  upon  the  policy- 
holder would  be  that  the  company  would  be  required 
to  pay  a  one  per  cent  tax  on  the  net  earnings,  ($10.11) 
or  ten  cents,  and  the  amount  of  loading  refunded  the 

6 


next  year  might  be  reduced  to  that  extent.  It  will  thus 
be  seen  that  the  burden  of  the  tax,  so  far  as  small 
policyholders  are  concerned,  will  not  be  very  heavy. 

Considerable  confusion  has  arisen  in  the  public 
mind  as  to  how  the  tax  on  insurance  companies  is  to 
be  assessed  and  collected.  It  is  suggested  that  the 
policyholder  who  does  not  have  $4,000  of  income 
ought  not  to  be  called  upon  to  pay  the  tax  nor  to  make 
an  affidavit  as  to  his  income. 

While  the  law  is  not  quite  as  clear  on  this  point  as 
might  be  wished,  its  general  purpose  seems  to  be  to 
treat  insurance  companies  exactly  as  other  corpora- 
tions are  treated.  They  can  deduct  from  gross  income 
all  sums  paid  as  losses,  all  expenses  and  all  sums  neces- 
sarily applied  to  reserves.  Upon  the  net  income  or  earn- 
ings a  tax  of  one  per  cent  is  levied.  It  is  assumed  for 
the  purpose  of  income  taxation  that  the  policyholder  in 
a  mutual  insurance  company  stands  in  the  same  rela- 
tion to  the  company  that  a  stockholder  in  any  ordin- 
ary business  corporation  does  to  the  company  in  which 
he  holds  stock.  The  question  of  whether  he  has  an  in- 
come of  $4,000  or  not  is  not  raised.  The  government 
looks  to  the  corporation  for  its  tax  and  is  not  con- 
cerned whether  the  men  who  compose  the  company 
are  stockholders  or  policyholders.  That  the  policy- 
holder is  not  required  to  make  a  return  of  the  income 
derived  from  dividends  would  seem  quite  clear  from 
that  portion  of  paragraph  D  of  the  law  which  reades : 

"Persons  liable  only  for  the  normal  income  tax 
shall  not  be  required  to  make  return  of  the  income  de- 
rived from  dividends  on  the  capital  stock,  or  from  the 
net  earnings  ^  "^  ^^  of  insurance  companies  taxable 
upon  their  net  income  as  hereinafter  provided." 

It    is    precisely    because   the    policyholder    is    not 


charged  with  the  tax  that  the  company  should  not  be 
permitted  to  deduct  the  full  amount  of  the  so-called 
dividends  paid,  any  more  than  an  ordinary  business 
corporation  should  be  allowed  to  deduct  as  a  legitimate 
expense  the  dividends  paid  to  its  stockholders.  In  other 
words,  the  eventual  distribution  of  profits  must  not  be 
treated  as  if  it  were  one  of  the  expenses  of  making 
such  profits.  But  it  will  be  urged  that  the  dividends 
are  not  wholly  profits,  but  are  partly  refund,  and  such 
refund  should  not  be  treated  as  income.  This  is  true, 
but  the  answer  is  that  a  refund  is  not  a  dividend 
though  it  may  be  called  by  that  name.  As  was  said 
in  the  case  of  Mut.  Life  Ins.  Co.,  v.  Commonwealth 
(128  Ky.  174,)  "the  law  looks  below  the  mere  appear- 
ance of  things  and  has  regard  to  the  reality."  Money 
refunded  is  not  "received"  and  should  not  be  treated 
as  income  whether  the  refund  is  made  immediately  or 
at  a  later  period.  As  a  bookkeeping  proposition  it  is 
immaterial  whether  the  insurance  companies  charge 
themselves  with  the  gross  amount  of  premiums 
and  then  deduct  the  refund  as  an  expense,  or 
charge  themselves  with  only  the  amount  received  and 
retained,  treating  the  remainder  as  a  mere  over-pay- 
ment which  can  not  be  regarded  as  income.  In  view 
of  the  decisions  of  the  courts  as  to  what  constitutes 
"dividends"  it  would  seem  that  the  latter  method 
would  be  the  more  appropriate. 

WHAT  THE  COURTS  HAVE  HELD 

It  is  often  contended  that  the  courts  have  held  that 
dividends  to  policyholders  are  not  income  and  cannot 
be  taxed  .  A  more  accurate  statement  would  be  to  say 
that  the  courts  have  held  that  money  only  constructive- 

8 


ly  received  should  not  be  treated  as  income.  An 
analysis  of  some  recent  decisions  will  make  the  dis- 
tinction clearer.  Of  course,  it  would  be  impossible  in 
the  limits  of  this  paper  to  discuss  all  the  varied  phases 
of  insurance  with  which  the  law  has  to  do  and  only  a 
brief  reference  to  three  decisions  affecting  dividends 
^^^ill  he  attempted. 

It  will  be  remembered  that  the  Corporation  Tax  Act 
of  August  5,  1909,  (Section  38)  provided  that  "every 
insurance  company  shall  be  subject  to  pay  annually  a 
special  excise  tax  with  respect  to  the  carrying  on  or 
doing  business  by  such  insurance  company  equivalent 
to  one  per  cent  upon  the  entire  net  income  over  and 
above  $5,000  received  by  it  from  all  sources  during 
such  year."  Among  the  deductions  permitted 
were  ''the  sums  other  than  dividends,  paid 
within  the  year  on  policy  and  annuity  con- 
tracts," etc.  As  identically  the  same  words 
in  respect  to  deductions  (but  with  the  comma 
omitted)  are  used  in  the  proposed  federal  income  tax 
law,  the  legal  construction  placed  upon  these  words  by 
the  courts  becomes  important. 

A.     Decision  of  the  Internal  Revenue  Department. 

The  question  first  arose  before  the  Commissioner 
of  Internal  Revenue.  Numerous  hearings  were  held 
during  a  period  of  six  months  and  in  December  1911, 
the  Commissioner  rendered  a  decision  to  the  effect 
that,  under  the  terms  of  the  law,  dividends  could  not  be 
deducted.  This  was  not  quite  equivalent  to  saying  that 
dividends  were  income  although  the  practical  result 
was  to  include  such  sums  in  net  income.  It  would 
hardly  be  claimed  for  example  that  family  and  per- 

9 


sonal  expenses  are  necessarily  net  income  because  they 
cannot  be  deducted  in  making  out  an  income  tax  re- 
turn. They  might  be  paid  out  of  accumulated  capital. 
In  the  hearings  before  the  Commissioner  the  main 
arguments  advanced  by  the  insurance  companies  were : 

First.  That  dividends  declared  by  mutual  and 
participating  companies  are  not  dividends  in  the  com- 
mercial sense  of  the  v^ord,  but  are  simply  refunds  to 
the  policyholder  at  the  time  the  annual  premium  of  the 
policy  contract  is  collected  which  over-charge  is  mere- 
ly held  in  trust  by  the  company  issuing  the  policy. 

Second.  That  even  if  it  were  conceded  that  divi- 
dends paid  to  the  policyholders  in  cash  were  dividends 
within  the  intent  of  the  statute  it  did  not  follow  that 
dividends  which  were  applied : 

(a)  To  the  payment  of  renewal  premiums, 

(b)  To  shorten  the  endowment  or  premium-pay- 
ing period 

(c)  To  purchase  paid-up  additions  and  annuities, 
belonged    in   the   same   category    and   should    be 

treated  as  income. 

The  reply  of  the  Commissioner  to  the  first  conten- 
tion was  that  the  law  clearly  prohibited  the  deduction 
of  dividends,  that  the  companies  had  always  treated 
such  sums  in  their  literature  and  otherwise  as 
dividends;  that  Congress  evidently  had  in  mind  the 
same  tiling  that  the  insurance  companies  had  been 
designating  as  dividends  and  that  whether  such  divi- 
dends are  dividends  in  the  commercial  sense  or  not 
they  constitute  what  Congress  specifically  prohibited 
from  being  deducted. 

In  answer  to  the  second  contention,  which  was  the 

10 


one  most  strenuously  insisted  upon  by  the  insurance 
companies,  the  commissioner  maintained  that  the 
dividends  which  were  the  property  of  the  poHcy- 
holders,  upon  being  transferred  to  the  company  by 
direction  of  the  poHcyholder,  became  income  and  the 
credit  given  did  not  constitute  such  a  counter-payment 
as  to  entitle  it  to  be  treated  as  a  deduction. 

In  accordance  with  these  views  the  Commissioner 
ruled  that  no  deduction  should  be  allowed  on  account 
of  dividends. 

B.     Decision  of  the  United  States  Circuit  Court. 

The  Mutual  Benefit  Life  Insurance  Company, 
having  been  compelled  to  pay  a  large  sum 
under  this  ruling,  paid  the  same  under  protest  and 
brought  suit  in  the  United  States  District  Court  for  the 
District  of  New  Jersey  to  recover  the  amount  thus 
paid.  It  should  be  noted,  however,  that  the  case 
(Mutual  Benefit  Life  Insurance  Company  vs.  Herold, 
198  Federal  Reporter  199.  July  29,  1912,)  did  not  in- 
volve cash  dividends  actually  paid  to  policyholders,  but 
only  the  dividends  (a),  (b)  and  (c)  referred  to  in 
the  second  contention  mentioned  above. 

The  decision  is  quite  lengthy  and  composed  largely 

of  citations  not  all  of  which  appear  to  support  the 

position  taken.     The  peculiar  angle  from  which  the 

subject  was  viewed  by  the  court  may  be  seen  in  the 

following  extract  from  the  decision : 

"In  seeking  to  ascertain  the  intention  of  Congress, 
it  seems  but  reasonable  to  assume,  in  the  absence  of 
anything  tO'  the  contrary,  that  it  uses  the  word 
"dividends"  as  applied  to  insurance  companies  in  the 
sense  it  had  long  and  generally  borne  in  insurance  mat- 
ters which  sense  had  moreover  been  confirmed  by  re- 
peated judicial  decisions.      The  term  should,  in  other 

11 


words,  be  given  what  might  not  inappropriately  be 
called  its  trade  signification.  Hence  when  it  refers  to 
dividends  ''paid"  it  means  dividends  paid  and  not  an 
application  of  excess  premium  payments  in  abatement 
or  redemption  of  subsequent  premiums.  The  word 
"paid"  as  used  by  Congress,  is  highly  significant. 
It  clearly  shows  that  it  had  cash  payments  in  mind.  It 
should  be  held  to  mean  dividends  which  have  been  paid 
in  cash  during  the  year  and  repaid  to  the  company  as 
premiums.  *  *  *  Such  a  construction  of  the  act  in 
nowise  contravenes  its  purpose  which  was  to  subject  to 
taxation  cash  dividends,  which,  as  statistics  show, 
form  a  very  large  item  in  insurance  business." 

At  the  risk  of  seeming  presumptuous  we  may  ven- 
ture the  suggestion  that  the  object  of  the  act  was  not 
the  taxation  of  cash  dividends,  but  the  taxation  of  net 
earnings ;  and  further  that  the  question  of  whether  or 
not  dividends  are  deductible  from  gross  income  hinges 
more  upon  the  elements  which  make  up  the  dividend 
than  upon  the  form  of  payment. 

It  will  require  an  unusual  degree  of  ingenuity  to 
reconcile  the  decisions  cited  in  the  above  case  with  the 
conclusion  arrived  at,  or,  for  that  matter,  with  each 
other.  This  is  illustrated  by  the  following  extracts, 
(the  italics  being  ours)  : 

"Such  return  of  over-payments,  whether  in  cash 
or  by  application  on  future  premiums,  or  by  increase 
of  the  amount  insured,  is  a  dividend.  This  is  the  mean- 
ing of  "dividend"  and  the  only  meaning  it  has  or 
can  have  in  connection  with  mutual  insurance." 

Fuller  V.  Metropolitan  Life  Ins.  Co.  of  N.  Y. 
(Conn.  41  At.  Rep.  4)  : 

"Now  the  truth  is  that  this  overpayment  (called 
dividend)  is  not  a  dividend  in  any  sense  of  the  term; 
nor  is  the  failure  of  the  company  to  collect  the  full 
amount  of  the  premium  in  after  years  a  credit  in  any 
sense  of  the  term." 

12 


(Mut.  Benefit  Life  Ins.  Co.  v.  Commonwealth  128 

Ky.  174.) 

"The  practice  is  to  take  an  account  every  year  of 
assets  and  HabiHties  and  to  give  the  insured  the  benefit 
of  the  surplus  either  by  way  of  reduction  of  premium 
or  by  way  of  addition  to  the  sum  insured.  It  can  make 
no  difference  in  principle  whether  the  surplus  is  so  ap- 
plied or  paid  hack  in  hard  cash.  In  either  case  it  is 
nothing  but  the  return  of  so  much  of  the  amount  con- 
tributed as  may  be  in  excess  of  the  amount  really  re- 
quired." 

Lord  McNaughton,  in  N.  Y.  Life  Ins.  Co.  v.  Styles 
59  L.  J.  Q.  B.  391;  L.  R.  14  App.    Cases  381,  1889.) 

The  cases  cited  are  in  substantial  agreement  that 
the  amount  paid  as  refund  should  not  be  charged  as 
income,  but  many  of  the  cases  ignore  the  element  of 
earnings.  Upon  that  point  the  United  States  District 
Court  has  this  to  say : 

"But  it  may  be  urged  that  the  fund  for  (from?) 
which  the  so-called  dividends  are  declared  on  mutual 
policies  is  likewise  largely  derived  from  interest  on 
the  company's  investments,  and  that  this  shows  that  in 
a  real  sense  such  dividends  are  after  all  declared  from 
the  earnings,  profits,  or  incomes  of  the  company.  This 
proposition  might  be  entitled  to  weight  were  it  not  for 
the  fact  that  in  so  far  as  the  fund  from  which  such 
dividends  are  declared  is  produced  from  interest  on 
the  company's  invested  funds,  it  has  already  been  sub- 
jected to  and  has  paid  taxes  under  the  act  in  question." 

The  fallacy  of  this  argument  lies  in  its  assumption 
that  the  net  earnings  or  income  included  in  the 
dividends  had  been  taxed.  The  Commissioner  of  In- 
ternal Revenue  having  ascertained  that  the  company,  in 
making  its  return  for  assessment  for  the  corporation 
tax  for  the  years  1909  and  1910,  had  deducted  among 
other  things  all  dividends  allowed  in  reduction  of  re- 

13 


newal  premiums  and  all  dividends  applied  to  purchase 
additional  insurance  or  to  shorten  endowment  terms, 
proceeded,  with  the  approval  of  the  Secretary  of  the 
Treasury,  to  amend  the  return  for  the  years  mentioned 
and  levied  an  additional  or  supplementary  assessment 
for  the  years  in  question  the  tax  amounting  (as  to  the 
two  items  of  dividends  mentioned  above)  to 
$49,485.77.  The  taxes  were  paid  under  protest  and 
suit  was  brought  in  the  Supreme  Court  of  New  York 
to  recover  the  amount  thus  paid.  The  suit  was  re- 
moved by  certiorari  to  the  United  States  District  Court 
D.  of  New  Jersey,  where  the  decision  was  rendered. 
The  Court  held  that  the  amount  of  tax  paid,  to-wit, 
$49,485.77  should  be  refunded  with  interest  from 
January  6,  1912,  which  was  presumably  the  date  when 
the  tax  was  paid  under  protest. 

It  thus  appears  that  whatever  element  of  net  earn- 
ings was  represented  by  the  dividends  in  question  had 
been  deducted.  If  it  had  not  been  there  would  have 
been  no  occasion  for  the  supplementary  assessment. 
This  point  can  perhaps  be  made  plainer  by  concrete 
figures.  In  the  example  which  was  given  on  page  — 
ante,  it  appeared  that  $10.11  of  the  dividend,  or  41.6 
per  cent,  was  net  earnings.  Now,  if  the  tax  at  one  per 
cent  amounted  to  $49,485.77,  the  amount  assessed  must 
have  been  $4,948,577,  which  proves  to  be  the  exact 
sum  of  the  amounts  reported  by  the  company  as 
"dividends  in  reduction  of  renewal  premiums"  received 
in  1909  and  1910.  Assuming,  for  the  sake  of  the  illus- 
tration, that  the  dividends  in  question  were  composed 
of  a  corresponding  proportion  of  earnings  it  would 
follow  that  41.6  per  cent  of  $4,948,677  or  $2,058,608 
of  earnings  embraced  in  the  dividends  were  practically 

14 


deducted  from  gross  income  in  making  the  original  re- 
turn. Therefore  in  the  instant  case  the  precise  earn- 
ings in  question  had  not  been  taxed  until  the  attempt 
was  made  by  the  supplementary  assessment. 

It  is  unfortunate  that  the  exact  method  of  com- 
putation adopted  by  the  company  in  making  its  return 
for  1909  and  1910  is  not  shown  in  the  pleadings  or 
opinions;  but  the  following  extract  from  the  brief  of 
counsel  for  the  insurance  company  is  significant  and 
throws  some  light  upon  the  point  at  issue : 

"The  question  is  whether  the  company's  income  in 
1909,  on  account  of  renewed  policies  was  $13,905,952 
as  claimed  by  the  plaintiff  (the  Insurance  Company) 
or  $16,046,049  as  claimed  by  the  defendant  (the  Col- 
lector), the  difference  between  these  two  sums, 
$2,140,097,  being  the  amount  allowed  in  abatement  of 
renewal  premiums;  and  whether  in  1910  it  was  $14,- 
270,488  as  claimed  by  the  plaintiff  or  $17,078,967  as 
claimed  by  the  defendant,  the  difference  between  these 
two  sums,  $2,808,479,  being  the  amount  allowed  in 
abatement  of  renewal  premiums.  These  sums  of  $2,- 
140,097  and  $2,808,479  comprise  the  items  set  forth 
in  plaintiff's  Bill  of  Particulars  as  so-called  dividends 
allowed  in  abatement  of  premiums,  applied  to  the  pur- 
chase of  paid-up  additions  and  to  shorten  the  endow- 
ment or  premium-paying  term." 

It  may  be  conceded  that  the  company  did  not  re- 
ceive in  cash  from  its  policyholders  the  full  amount 
which  was  abated  in  the  form  of  dividends.  But  the 
fact  remains  that  the  company  had  on  hand  the  money 
necessary  to  pay  the  dividends.  It  offered  to  pay  the 
sum  in  cash  to  its  policyholders.  Where  did  it  get  this 
money?  Partly  from  overpayments  of  premiums  and 
partly  from  earnings  and  such  earnings  were  those  of 
the  taxing  year.  The  company  deducted  the  whole 
amount  of  dividends  not  by  a  formal  deduction  of  such 

15 


moneys  as  dividends,  but  by  charging  itself  with  only 
so  much  of  the  premiums  applied  to  renewals,  etc.,  as 
was  actually  paid  in  cash,  ignoring  the  sums  which  the 
policyholders  directed  them  to  apply  to  renewals.  The 
result  was  exactly  the  same  as  it  would  have  been  if 
the  company  had  charged  itself  in  the  year  1909  with 
gross  premiums  to  the  amount  of  $16,046,049  and  then 
claimed  a  deduction  for  the  dividends  applied  to  re- 
newals, etc.,  of  $3,140,097,  and  in  1910  had  charged 
itself  with  gross  premiums  to  the  amount  of  $17,078,- 
967,  and  then  claimed  a  deduction  of  $3,808,479.  The 
effect,  in  either  case,  would  be  tO'  reduce  the  net  income 
on  which  tax  was  eventually  paid.  So  far  as  the  ele- 
ment of  refund  in  the  dividends  was  concerned  this 
course  was  not  objectionable;  but  the  element  of 
earnings  stands  upon  a  different  footing.  It  con- 
stitutes a  part  of  the  net  income  upon  which  the  com- 
pany should  be  taxed. 

C.     Decision  of  U.  S.  Court  of  Appeals. 

It  is  somewhat  curious  that  when  the  case  was  ap- 
pealed by  the  Government  the  higher  court  fell  into 
the  same  error.  In  fact  it  would  seem  to  have  been  up- 
on this  point  alone  that  the  decision  of  the  Circuit 
Court  was  sustained.  The  decision  of  the  United  States 
Circuit  Court  of  Appeals  for  the  third  circuit  (Octo- 
ber Term  1913.  No.  1693)  as  given  on  page  1311  of 
the  Congressional  Record,  was  as  follows :  Herman  C. 
H.  Herold,  collector,  v.  Mutual  Benefit  Life  Insurance 
Co.,  plaintiff  below. 


16 


ERROR  TO  THE  DISTRICT  COURT  OF  THE  UNITED 
STATES  FOR  THE  DISTRICT  OF  NEW  JERSEY. 

Before  Gray,  Buffington  and  McPherson,  circuit 
judges. 

Per  Curiam  : 

Certain  taxes  for  1909  and  1910  were  levied 
against  the  insurance  company  by  two  supplementary 
assessments  under  the  act  of  1909.  The  company  paid 
under  protest,  and  afterwards  recovered  judgment 
against  the  collector  for  practically  the  whole  amount 
levied.  Several  questions  were  raised  and  decided  be- 
low, but  in  this  court  only  one  question  needs  attention. 
Does  the  act  tax  the  so-called  * 'dividends"  awarded 
annually  to  policyholders  ?  The  answer  must  be  in  the 
negative,  unless  such  "dividends"  form  a  part  of  the 
company's  "net  income  *  *  *  received  by  it  *  *  * 
during  such  year."  If  they  do  not  arise  from  income 
received  during  the  tax  year,  but  from  income  re- 
ceived during  a  previous  year.  Congress  has 
not  taxed  them;  or  perhaps  it  is  more  correct  to  say, 
Congress  has  not  taxed  them  more  than  once. 
Concededly,  they  have  been  taxed  once  with 
the  other  net  income  of  the  particular  year  dur- 
ing which  the  Company  actually  received  them 
in  cash;  if,  therefore,  they  are  to  be  taxed  more  than 
once,  it  is  well  settled  that  the  language  imposing  such 
an  exceptional  burden  should  be  clear  and  unambigu- 
ous. But  we  need  not  discuss  the  subject;  that  duty  has 
been  performed  by  Judge  Cross  with  such  fullness  and 
ability  that  we  cannot  do  better  than  adopt  his  opinion. 
The  case  in  the  District  Court  is  reported  in  198  Fed., 
at  page  199,  and  the  discussion  we  refer  to  extends 

17 


from  page  200  to  page  212  inclusive.  But  we  do  not 
adopt  what  is  said  on  page  212  concerning  dividends 
on  full-paid  participating  policies,  nor  what  is  said  on 
the  same  page  concerning  stock  companies ;  not  because 
we  wish  to  suggest  disapproval,  but  merely  because  no 
opinion  about  these  matters  is  called  for  now,  as  they 
do  not  seem  to  be  directly  involved. 

The  judgment  is  affiirmed." 

A  second  error  into  which  the  Circuit  Court  fell  in 
its  discussion  of  the  case  seems  to  have  arisen  from  its 
failure  to  note  the  exact  wording  and  punctuation  of 
the  law.  It  will  be  remembered  that  the  Court  was 
greatly  impressed  with  the  fact  that  Congress  used  the 
words  "dividends  paid,"  and  argued  from  this  that 
only  dividends  actually  paid  in  cash  could  have  been 
meant.  With  all  due  deference  to  the  learned  court 
we  venttire  the  suggestion  that  that  was  not  what 
Congress  said  and  still  less  what  it  meant.  Had  the 
court  consulted  the  original  law  as  it  appears  in  the 
United  States  Statutes  at  Large,  it  would  have  found 
that  it  reads  thus : 

"And  in  the  case  of  insurance  companies  the  sums 
other  than  dividendSj  paid  zvithin  the  year  on  policy 
and  annuity  contracts/'  The  phrase  appears  three 
times  in  the  law  and  each  time  with  the  comma  after 
the  word  ''dividends."  (See  United  States  Statutes  at 
Large,  Gist  Congress,  1909,  1911.  Chapter  6,  Sec- 
tion 38,  page  113,  lines  29  and  59  and  page  115,  line 
7.)  The  Court  may  have  been  misled  by  the  briefs  as 
both  sides  erred  in  printing  the  sentence  sometimes 
with  and  sometimes  without  the  comma.  In  the  printed 
brief  of  counsel  for  the  Company  in  the  Appellate 

18 


Court  on  page  21,  the  heading  of  the  fourth  conten- 
tion, in  large  black  letter  type  was  as  follows : 

"From  the  Provision  for  Deduction  from  Gross  In- 
come of  "sums  other  than  dividends  paid,"  there  is  no 
implication  that  Congress  intended  that  Dividends 
Allowed  in  Reduction  of  Premiums  should  be  included 
in  Income." 

In  the  argument  which  follows  this  heading  it  is 
said: 

"This  is  the  only  mention  in  the  Act( !)  of  the  word 
'dividends'  in  the  insurance  sense,  and  it  is  significant 
that  it  is  coupled  with  the  word  'paid'  which  plainly 
describes  a  cash  transaction.  This  signification  of  the 
word  'paid'  throughout  the  law  is  the  chief  ground  for 
the  'cash  basis'  rule  adopted  by  the  court  below  and  ap- 
parently unchallenged  here." 

But  the  law  does  not  speak  of  "dividends  paid."  It 
speaks  of  "sums,"  "paid  within  the  year  on  policy  and 
annuity  contracts"  and  dividends  are  expressly  ex- 
cepted from  these  sums.  The  phrase  would  perhaps 
have  been  clearer  had  it  read :  "the  sums  paid  within 
the  year,  other  than  dividends,  on  policy  and  annuity 
contracts." 

We  are  aware  of  the  general  rule  in  legal  construc- 
tion that  the  punctuation  of  an  act  or  its  title  is  not 
controlling  for  the  purpose  of  ascertaining  its  real 
meaning.  But  it  is  equally  well  established  that  courts 
may  give  effect  to  punctuation  in  determining  the  true 
m.eaning  of  doubtful  passages.  A  strong  reason  for 
giving  the  comma  its  full  significance  in  this  case  is 
that  only  in  this  way  can  the  sentence  be  made  co- 
herent and  intelligible.  If  all  the  words  following 
"dividends"  are  construed  to  relate  to  dividends  then 
the  word  "sums"  is  left  hanging  in  the  air,  unexplained 

19 


and  unrelated  to  anything  which  follows  or  precedes. 
If  however  the  words,  "other  than  dividends"  is 
treated  as  a  parenthetical  clause  relating  wholly  to 
"sums  paid  within  the  year  on  policy  and  annuity  con- 
tracts" we  have  a  complete  and  intelligible  statement, 
and  one  which  may  be  fairly  supposed  to  express  the 
true  intent  of  Congress  that,  in  computing  net  income, 
dividends,  as  such,  should  not  be  deducted. 

In  what  has  been  said  of  the  decisions  above  there 
has  been  no  desire  to  indulge  in  invidious  criticism.  We 
simply  contend  that  these  decisions  fall  far  short  of 
demonstrating  in  any  satisfactory  manner  that 
dividends  paid  or  credited  to  policyholders  by  mutual 
insurance  companies  should  be  deducted  from  gross  in- 
come regardless  of  the  extent  to  which  they  are  made 
up  of  earnings. 

Of  course  it  is  conceivable  that  there  might  be 
policy  dividends  which  consist  wholly  of  refund.  If 
there  are  any  such  and  the  company  had  charged  it- 
self with  the  full  amount  of  premiums  in  the  first  in- 
stance then  in  all  fairness  the  company  should  be  per- 
mitted to  deduct  such  amounts  whether  they  are  called 
dividends  or  not.  So  too  if  a  portion  of  the  dividend 
is  refund  and  the  remainder  earnings,  the  over-pay- 
ment should  not  be  treated  as  income.  The  principle 
is  plain,  but  the  practical  application  of  the  principle  to 
the  varied  and  complicated  phases  of  life  insurance  is 
not  free  from  difficulty. 


20 


CASH  BASIS 

It  was  decided  by  the  United  States  Circuit  Court 
in  the  Herold  case  that  the  returns  of  insurance  com- 
panies should  be  made  out  on  the  cash  basis.  The 
wording  of  the  law  seems  to  justify  this  conclusion, 
but  there  are  some  obvious  difficulties  in  making  re- 
turns on  that  basis.  If  that  plan  were  strictly  followed 
the  amount  of  premium  with  which  a  mutual  company 
would  charge  itself  would  be  the  actual  cash  received 
in  thfe  form  of  premiums.  Such  amount  would  not 
include  the  sums  allowed  as  dividends  and  applied  on 
renewals,  additions,  etc.  Of  course  it  would  follow 
also  that  such  sums,  not  having  been  paid  as  cash,  could 
not  be  allowed  as  deductions.  Thus  the  sums  applied 
in  abatement  would  be  entirely  eliminated  from  the 
computation.  But  such  sums  are  composed  of  two  ele- 
ments, earnings  and  refund.  The  earnings  should  not 
be  deducted  while  the  refund  should.  In  a  computa- 
tion to  determine  what  are  net  earnings  the  net  earn- 
ings themselves  should  not  figure.  The  distinction 
should  be  kept  clear  between  expenses  necessary  to 
make  the  earnings  and  the  distribution  of  the  earnings 
after  they  are  made. 

While  some  of  the  companies  have  contended  for 
the  cash  basis  of  accounting  in  connection  with  their 
returns  under  the  Corporation  Tax  Law,  we  venture 
the  suggestion  that  such  a  basis  would  work  out  un- 
fairly in  the  case  of  every  company  which  is  increas- 
ing its  business  largely  every  year.  The  growth  con- 
sists mainly  in  what  is  called  ''new  business."  Such 
new  business  is  represented  by  payments  of  first  prem- 
iums which  are  in  cash  and  help  to  swell  the  item  of 

21 


gross  income.  But,  on  the  cash  basis  of  accounting, 
the  vastly  increased  Habilities  which  have  been  incurred 
will  not  appear  as  a  countercharge.  It  may  be  sug- 
gested that  this  increase  in  liabilities  would  be  taken 
care  of  by  the  "net  addition,  if  any,  required  by  law  to 
be  made  within  the  year  to  reserve  funds,"  which  the 
law  expressly  permits  to  be  deducted  from  gross  in- 
come. But  an  examination  of  the  annual  reports  of  a 
prosperous  company  will  show  that  a  considerable 
margin  would  be  left  over.  In  one  of  the  larger 
mutual  companies  the  increase  in  the  amount  of  in- 
surance written  and  paid  for  in  1912  over  the  same 
item  for  the  previous  year  was  $14,970,476,  while  the 
net  addition  to  reserve  was  only  $14,023,144.  The  in- 
crease in  premium  receipts,  which  was  over  $3,000,000, 
was  somewhat  in  the  nature  of  an  increase  of  capital 
consisting  of  borrowed  money,  and  it  is  not  perceived 
that  the  cash  method  of  accounting  would  permit  of 
any  adequate  countercharge. 

In  the  case  of  a  stock  life  insurance  company  the 
dividends  paid  to  the  stockholders  would  not  be  de- 
ductible from  gross  income.  If  the  company  is  what 
is  sometimes  called  a  "mixed"  company,  or  one  which 
pays  a  fixed  dividend  to  its  stockholders  and  then  dis- 
tributes to  its  policyholders  any  surplus  profits,  such 
dividends  could  not  be  deducted  from  income.  In  such 
case  the  policyholder  might  be  compared  to  the  holder 
of  common  stock  while  the  original  stockholders  have 
the  preferred  stock.  But  even  in  this  case  if  any  por- 
tion of  the  dividends  to  policyholders  were  returns  of 
over-payments,  such  returns  should  be  deducted  from 
gross  income. 


22 


In  the  Circuit  Court  decision  cited  above  it  was 
stated  that  the  premiums  paid  to  stock  companies  were 
not  loaded.  It  is  true  that  the  loading  in  such  com- 
panies is  slight  as  compared  with  mutuals;  but  it  is 
only  necessary  to  compare  the  investment  profits  with 
total  profits  in  such  companies  to  see  that  there  must 
have  been  a  very  substantial  element  of  loading. 

In  a  mutual  company  the  distribution  of  its  net 
earnings  to  its  policyholders  is  a  matter  subsequent  to 
the  making  and  accumulation  of  such  net  earnings  and 
that  is  true  whether  such  earnings  are  paid  in  cash  or 
allowed  in  abatement  of  renewal  premiums,  etc.  There- 
fore we  maintain  that  the  refund  element  of  dividends 
is  the  only  element  which  ought  to  enter  into  the  com- 
putation of  net  income  and  then  only  for  the  purpose 
of  ascertaining  the  net  amount  of  cash  received  from 
premium  payments. 

It  will  perhaps  tend  to  make  our  position  clearer  if 
we  present  a  very  condensed  account  or  return  for  a 
mutual  insurance  company  in  which  it  will  be  observed 
that  dividends  as  such  have  no  place.  The  sums  used 
in  this  account  are  those  given  in  the  annual  statement 
of  a  mutual  company  for  the  year  1911  with  the  ex- 
ception of  the  amount  of  refunds,  which  is  arbitrarily 
assumed  to  be  58.4  per  cent  of  the  dividends  and  the 
net  addition  to  the  reserve  which  is  taken  to  be  the 
difference  between  the  legal  reserv^e  required  at  the  be- 
ginning of  the  year  and  that  required  at  the  beginning 
of  the  next  year. 


28 


RECEIPTS 

Gross  premiums  $40,421,263.23 

Less  refunds  7,364,427.61 

$33,056,835.62 

Interest  and  rents 13,422,949.48 

All  other  receipts 690,929.07 

$47,170,714.17 

DISBURSEMENTS 

Claims  by  death $10,830,204.59 

Matured  endowments 2,838,559.37 

Annuities    71,322.62 

Surrendered  policies 9,277,054.62 

Expenses     (Commissions, 

salaries,  taxes,  etc.) 7,209,854.85 

Net  addition  required  to 

be     made     to     reserve 

funds  including  reserve 

for  annuities  14,023,144.00 

$44,250,140.05 

*Net   Income $  2,920,574.12 

It  is  frankly  conceded  that  the  above  method  of 
computation  would  not  answer  in  every  case  and 
possibly  in  no  case  without  some  minor  modifications. 
It  may  serve  however,  as  a  tentative  basis  from 
which  a  workable  formula  may  be  devised,  and  it 
would  seem  to  meet  the  requirements  of  the  proposed 
Federal  income  tax  law. 

The  objections  which  will  probably  be  made  by  the 
insurance  companies  to  this  computation  is  that  it  is 
not  on  the  cash  basis  in  so  far  as  it 
reckons  as  premiums  money  which  was  not  received, 
to-wit,  that  portion  of  the  dividends  which  was  com- 
posed of  earnings.  Our  reply  is  that  this  sum  was  in 
the  hands  of  the  company  in  cash  ready  tO'  be  paid  to 
the  policyholder,  but  the  policyholder  directed  it  to  be 
applied  toward  his  premium  and  the  company  carried 
out  his  direction  and  thus  received  the  money.     The 

*It  is  interesting  to  note  that  in  the  case  above  mentioned  the 
amount  of  insurance  in  force  was  $1,147,273,523,  so  that  the  in- 
come tax  would  amount  to  only  two  and  one-half  cents  on  each 
$1,000  of  insurance. 

24 


roundabout  method  of  paying  the  money  to  the  policy- 
holder and  then  having  him  pay  it  back  would  have  at- 
tained exactly  the  same  result. 

As  was  said  by  the  Commissioner  of  Internal 
Revenue  in  the  Herold  case  above :  'The  contention 
that  the  company  does  not  receive  the  amount  of 
money  belonging  to  the  policyholder  which  is  in  the 
physical  possession  of  the  company,  and  which  the 
policyholder  directs  to  be  taken  and  added  to  the 
amount  which  he  remits  and  thus  pay  his  premium 
liability,  is,  moreover,  not  acceptable  as  an  accounting 
proposition." 

IMPORTANCE  OF  CLEARNESS  IN  THE  LAW 

It  is  very  important  that  the  law  should  be  so  clear 
and  explicit  that  no  question  as  to  its  meaning  can 
possibly  arise.  In  the  case  of  the  Wisconsin  income 
tax  law  more  irritation  and  dissatisfaction  were 
caused  by  certain  ambiguous  and  complex  provisions 
than  by  the  actual  collection  of  the  tax.  The  average 
business  man  rightly  feels  that  the  law  ought  to  be  so 
plain  that  he  can  ascertain  just  what  it  requires  of  him 
without  being  compelled  to  resort  to  legal  advice  or 
litigation  in  the  courts. 

The  proposed  federal  income  tax  law  marks  a  new 
departure  in  our  fiscal  system  and  is  in  many  respects  a 
distinct  advance  upon  any  previous  law  on  the  subject. 
In  so  far  as  it  breaks  new  ground  it  is  totally  lacking 
in  precedents  which  would  aid  in  its  construction.  The 
legal  fraternity,  the  courts  and  people  generally  are  not 
familiar  with  the  subject  of  income  taxation,  and  this 
emphasizes  the  importance  of  having  the  law  very 
simple,  direct  and  unequivocal  in  its  phraseology. 

25 


It  is  extremely  difficult  to  frame  a  law  of  this  kind 
so  as  to  meet  every  possible  contingency  and,  when  it 
is  put  to  the  test  of  actual  operation,  some  defects  and 
omissions  will  no  doubt  be  discovered;  but,  so  far  as 
it  goes,  the  public  has  a  right  to  demand  that  it  be  ex- 
pressed in  simple  and  intelligible  language.  The  de- 
partment to  which  the  administration  of  the  law  is  en- 
trusted will  have  quite  enough  to  do  without  being 
called  upon  to  solve  problems  essentially  judicial  or 
legislative  in  their  character.  Better  a  positive  enact- 
ment which  proves  to  be  a  mistake  and  has  to  be  cor- 
rected by  an  amendment,  than  an  ambiguous  provision 
which  is  blind  and  confusing,  leading  to  long-drawn 
out  litigation,  with  conflicting  decisions  in  different 
courts  until  the  original  intent  and  purpose  of  the  law 
are  lost  in  a  maze  of  legal  entanglements. 

The  framers  of  the  proposed  income  tax  law  have 
evidently  given  the  subject  a  great  deal  of  painstaking 
study  and  have  presented  a  measure  which  is  much 
more  carefully  drawn  than  the  average  legislative  en- 
actment. Nevertheless  it  is  not  yet  perfect  and  a  num- 
ber of  amendments  are  still  needed  in  order  to  make  the 
exact  intent  and  purpose  of  the  act  entirely  clear. 

AMENDMENTS  TO  THE  LAW 

(a)     As  to  dividends: 

The  original  bill.  No.  H.  R.  10  provided  (p.  146) 
that  net  income  should  be  ascertained  ''by  deducting 
from  the  gross  amount  of  the  income  of  such  corpo- 
ration, received  zvithin  the  year  from  all  sources,  all 
losses  actually  sustained  within  the  year  and  in  the 
case  of  insurance  companies  the  sums  other  than  the 
amounts  paid  within  the  year  on  policy  and  annuity 

26 


contracts  to  policyholders  as  dividends  or  as  return  of 
premium  payments,  and  the  net  addition^  if  any,  re- 
quired by  law  to  be  made  within  the  year  to  reserve 
funds.'' 

It  will  be  noticed  that  the  last  clause  which  ap- 
peared in  four  places  in  the  bill  was  ambiguous  in  not 
showing  what  ''sums"  were  meant,  the  words  "other 
than"  evidently  governing  all  that  followed. 

As  the  bill  was  read  in  the  House  on  May  6,  the 
clause  appeared  in  the  following  form:  (p.  1206  Cong. 
Record.) 

"And  in  case  of  insurance  companies  the  net 
addition,  if  any,  required  by  law  to  be  made  within  the 
year  tO'  reserve  funds  and  the  sums  other  than 
dividends  or  return  of  premium  payments  paid  ivithin 
the  year  on  policy  and  annuity  contracts/* 

Subsequently  the  words  "or  return  of  premium 
payments"  were  stricken  out  so  that  the  bill  as  it  went 
to  the  Senate  now  reads : 

''And  in  case  of  insurance  companies  the  net  addi- 
tion, if  any,  required  by  lazv  to  be  made  zvithin  the 
year  to  reserve  funds  and  the  sums  other  than 
dividends  paid  within  the  year  on  policy  and  annuity 
contracts." 

This  provision  is  found  in  identically  the  same 
form  on  pages  152,  153,  156  and  157  of  the  new  law 
and  it  is  objectionable  in  so  far  as  it  repeats  the 
language  of  the  corporation  tax  law  without  the  aid 
of  the  significant  comma  after  "dividends."  It  is  a 
phraseology  which  has  given  rise  to  expensive  litiga- 
tion and  has  resulted  in  decisions  to  the  effect  that  only 
cash  dividends  can  be  deducted.  As  such  a  construc- 
tion does  not  harmonize  with  the  general  intent  of  the 

27 


new  law,  it  is  to  be  hoped  that  the  Senate  will  change 
the  wording,  or  at  least  the  punctuation  of  the  sentence, 
so  that  no  further  doubts  can  arise  as  to  its  meaning. 
This  could  be  done  by  putting  the  words  "other  than 
dividends"  in  parenthesis,  or  by  adding  a  proviso  along 
the  lines  of  the  one  which  immediately  follows  it  in  re- 
ference to  mutual  fire  insurance  companies. 

(b)     As  to  proceeds  of  policies : 

There  is  also  a  latent  ambiguity  in  the  words  "sums 
paid  within  the  year  on  policy  and  annuity  contracts," 
if  only  such  sums  are  meant  as  represent  repayment 
of  principal. 

As  the  bill  was  originally  introduced,  April  7,  1913, 
it  provided  (H.  R.  10,  pp.  134,  135)  : 

"Net  income  *  *  *  shall  include  *  *  *  income 
derived  from  any  source  whatever,  including  the  in- 
come from  but  not  the  value  of  property  acquired  by 
bequest,  devise  or  descent,  and  also  the  proceeds  of  life 
insurance  policies  paid  upon  the  death  of  the  person 
insured." 

As  it  was  not  clear  from  this  language  whether  the 
proceeds  of  life  insurance  policies  were  to  be  deducted 
or  not,  the  last  clause  beginning  with  "and  also"  was 
stricken  out  and  the  following  proviso  substituted : 

"PROVIDED,  That  the  proceeds  of  life  insurance 
policies  paid  upon  the  death  of  the  insured  shall  not  be 
included  as  income." 

Subsequently  this  provision  was  amplified  sO'  as  to 
read  as  follows  (H.  R.  3321  p.  139)  : 

"PROVIDED,  That  the  proceeds  of  life  insurance 
policies  paid  upon  the  death  of  the  person  insured  or 
payments  made  by  or  credited  to  the  insured,  on  life 
instu'ance,  endowment,  or  annuity  contracts,  upon  the 
return  thereof  to  the  insured  at  the  maturity  of  the 


term  mentioned  in  the  contract,  shall  not  be  included 
as  income." 

This  is  the  form  in  which  the  proviso  is  found  in 
the  bill  now  pending  before  the  Senate  and  it  should  be 
noted :  First,  that  this  provision  relates  to  individuals 
and  not  to  corporations;  Second,  that  the  word  *'in- 
stired'*  where  it  occurs  the  third  time  should  evidently 
be  "insurer"  as  the  contract  is  returned  to  the  com- 
pany. If  however,  the  words  "return  thereof"  refer 
back  past  the  word  "contracts"  to  "proceeds"  then  "in- 
sured" is  correct.  Third.  The  law  refers  only  to  pay- 
ments made  "at  the  maturity  of  the  term  mentioned  in 
the  contract." ;  Fourth.  No  distinction  is  made  be- 
tween profits  and  principal  and  the  language  is  broad 
enough  to  cover  both. 

In  the  debate  upon  this  paragraph  (Cong.  Rec.  p. 
1222)  Mr.  Stafford  proposed  to  amend  by  adding  after 
the  word  "insured"  the  words : 

"Or  amounts  paid  to  the  assured  or  his  assigns  in 
fulfillment  or  settlement  of  his  policy  contract." 

This  was  suggested  for  the  purpose  of  making  it 
clear  that  policies  surrendered  would  not  be  taxable, 
even  though  the  surrender  occurred  prior  to  the"ma- 
turity  of  the  term  mentioned  in  the  contract."  In  the 
discussion  which  followed  Mr.  Underwood  gave  it  as 
his  opinion  that  the  law  was  broad  enough  to  cover 
surrendered  policies,  but  he  was  speaking  about  the 
"termination  of  the  contract"  which  is  quite  a  different 
thing  from  "maturity  of  the  term  mentioned  in  the 
contract."  As  there  were  several  members  who 
differed  from  him  sharply  on  this  point  and,  grave 
doubts  were  expressed  as  to  the  force  and  effect  of  the 
law,  it  would  seem  that  some  further  amendment  is 

29 


necessary.  We  venture  to  suggest  that  the  words 
"at  the  maturity  of  the  term  mentioned  in 
the  contract"  might  well  be  dispensed  with  or  at 
least  the  words,  "in  case  of  surrender,  cancellation,  or," 
could  be  inserted  before  "at"  and  another  slight  change 
made  so  that  it  would  read : 

"Upon  the  return  of  said  proceeds  to  the  insured  in 
case  of  surrender,  cancellation,  or  the  maturity  of  the 
term  mentioned  in  the  contract." 

In  regard  to  the  fourth  point  mentioned  above  it 
may  be  conceded  that  the  provision  on  page  138  of  H. 
R.  3331  in  its  final  form  does  not  apply  to  corpora- 
tions and  this  brings  us  back  to  a  consideration  of  what 
is  meant  by  the  words  (pp.  151,  153,  156,  157)  "sums" 
*  *  *  "paid  within  the  year  on  policy  and 
annuity  contracts." 

It  is  quite  clear  from  the  discussions  and  debates 
in  the  House  that  the  framers  and  sponsors  of  the 
proposed  Federal  income  tax  law  intended  to  provide 
for  a  tax  on  the  net  earnings  of  mutual  insurance  com- 
panies and  did  not  intend  that  any  portion  of  the 
dividends  or  proceeds  of  policies  should  be  deducted 
from  gross  income  unless  such  portion  represented  re- 
fund or  repayment  of  principal,  and  even  then,  only 
when  it  was  definitely  segregated  from  the  other  ele- 
ments of  the  payment. 

In  his  speech  of  May  1,  Mr.  Hull,  who  drew  the 
bill,  said: 

"My  judgment  is  that  the  accumulations  of  these 
companies,  which  arise  from  savings  in  expenses, 
savings  in  mortality,  savings  from  lapses  and 
surrenders,  and  profits  from  excess  interest 
earnings,  when  considered  in  the  aggregate,  are  clearly 
of  such  a  character  as  to  merit  the  payment  of  the 

30 


proposed  tax.  But  when  it  is  proposed  to  impose  the 
tax,  the  question  of  premium  overcharges  is  now 
brought  up  for  discussion."  *  *  *  ''If  the  companies 
would  keep  the  question  of  premium  assessments  and 
OA^ercharges  strictly  within  a  category  to  themselves 
and  not  mix  and  confuse  them  with  the  profits  derived 
from  the  sources  I  have  enumerated,  I  think  it  would 
then  be  possible  for  the  law  to  deal  with  the  one  with- 
out affecting  the  other." 

In  the  debate  on  the  bill  May  6,  Mr.  Hull  said : 

"No  part  of  the  principal  invested  in  insurance 
which  comes  back  to  the  insured  during  life  is  con- 
sidered taxable  income  any  more  than  the  return  of 
money  which  he  might  have  loaned  to  another  or  a 
deposit  that  he  might  have  made  in  the  bank." 

'The  amendment  which  was  adopted  includes  the 
proceeds  of  life  insurance  policies  paid  on  the  death  of 
the  person  insured  and  also  includes  the  return  of  any 
and  all  sums  which  a  person  invests  in  insurance  and 
received  back  at  one  time  or  at  periodical  times  during 
his  life  as  distinguished  from  any  actual  gains  or  pro- 
fits which  he  derives  out  of  the  investment." 

In  the  debate  of  May  6,  (p.  1224  Cong.  Record) 
Mr.  Underwood  made  the  following  statement  in 
reference  to  surrendered  policies  : 

"When  that  policy  is  returned  there  may  be  a  por- 
tion of  it  that  is  principal  and  a  portion  of  it  that  is 
profit,  and  probably  there  is.  Under  that  contract  they 
will  return  the  principal  and  they  will  return  some  of 
the  profit.  Now  the  principal  returned  under  the 
amendment  that  w^e  adopted  this  afternoon  will  not  be 
taxed.  But  if  there  is  a  profit  returned  it  will  be 
taxed." 


"MR.  TREADWAY.  Mr.  Chairman  I  would  like 
to  ask  the  gentleman  from  Alabama  for  a  little  further 
explanation  of  his  definition.  I  understood  him  to  say 
at  the  beginning  of  his  remarks  that  there  would  be  no 

31 


tax  on  an  insurance  policy  on  termination  of  the  con- 
tract. 

MR.  UNDERWOOD.    I  did  not  say  exactly  that. 

MR.  TREADWAY.  I  thought  those  were  the 
words  that  the  gentleman  used. 

MR.  UNDERWOOD.  No;  I  said  there  would  be 
no  tax  on  the  principal  that  was  paid  back  to  the  in- 
sured at  the  termination  of  the  contract,  but  that  there 
would  be  a  tax  on  the  profits. 

MR.  TREADWAY.  Yes,  I  understood  that,  but 
you  did,  use  the  expression  'on  the  termination  of  the 
contract.'  Now,  I  would  like  to  go  a  little  further  as  to 
the  meaning  of  'termination  of  the  contract.'  For  in- 
stance, if  you  have  a  20-year  endowment  policy,  and, 
as  the  gentleman  from  Wisconsin  (Mr.  Stafford)  is 
suggesting,  you  desire  to  surrender  it  and  get  the  cash 
surrender  value,  do  you  consider  that  as  the  termina- 
tion of  the  contract  ? 

MR.  UNDERWOOD.    Unquestionably. 

MR.  TREADWAY.  In  other  words,  if  the 
policy  has  run  15  years,  and  you  took  the  cash  surren- 
der value,  there  would  be  no  tax  on  the  principal  of 
that  policv  at  the  end  of  the  15  years? 

MR.  "underwood.  ''Unquestionably  there 
would  not  be." 

The  above  quotations  are  amply  sufficient  to  show  a 
general  intent  to  tax  net  income  and  not  to  tax  return 
of  principal.  But  it  must  be  kept  in  mind  that  the  real 
question  is  not  so  much  whether  the  net  income  of  life 
insurance  companies  shall  be  taxed,  as  it  is,  how  shall 
the  net  income  be  determined.  As  the  law  now  stands 
it  provides  that  in  the  case  of  corporations  net  income 
shall  be  ascertained  by  deducting  from  the  gross  in- 
come : 

1st.     Ordinary  and  necessary  expenses. 
3nd.     Losses. 

Under  the  second  head  there  is  a  special  provision 

32 


that  in  the  case  of  insurance  companies  there  may  also 
be  deducted : 

(a)  The  net  addition,  if  any,  required  by  law  to 
be  made  within  the  year  to  reserve  funds ; 

(b)  The  sums  other  than  dividends  paid  within 
the  year  on  policy  and  annuity  contracts. 

It  will  be  noticed  that  there  are  no  qualifications  on 
"sums"  *  *  *  paid  on  policy  and  annuity  contracts" 
other  than  the  express  exception  of  dividends  and  the 
limitation  to  the  taxing  year.  The  law  does  not  say  : 
'^that  part  of  sums,  other  than  dividends,  paid  with- 
in the  year  on  policy  and  annuity  contracts,  which  rep- 
resents repayment  of  principal/'  From  what  wa§  said 
in  the  debates  one  might  suppose  that  the  law  made 
some  such  provision,  but  we  fail  to  find  any  statement 
of  that  sort  and  venture  the  opinion  that  the  law  in  its 
present  form  suggests  the  proper  construction,  viz  :  that 
the  whole  of  the  "sums"  referred  to  shall  be  deducted 
from  gross  income.  To  read  into  the  law  a  require- 
ment that  only  repayment  of  principal  should  be  de- 
ducted would  lead  to  many  difficulties  and  complica- 
tions. This  may  be  illustrated  by  the  following  con- 
crete examples : 

A.  insures  his  life  December  15,  1913  for  $2,500 
paying  first  premium  of  $100.  He  dies  December  16 
and  his  w^idow  receives  $2,500  in  settlement  of  the 
death  loss  December  30.  The  company  suffers  a  net 
loss  of  $2,400,  but  in  making  its  return  for  the  year 
1913  it  would  charge  itself  with  $100  of  premium  and 
deduct  $100  as  repayment  of  principal.  The  $2,400  is 
paid  out  of  the  reserve  funds  accumulated  chiefly  in 
previous  years.  Such  funds  in  so  far  as  they  have  been 
increased  by  net  earnings  have  already  paid  taxes  four 
years  under  the  corporation  tax  law. 

33 


B.  had  a  paid-up  20-year  policy  of  $10,000  the  last 
payment  having  been  made  in  1912.  He  dies  December 
16,  1913,  and  the  death  loss  is  paid  December  30,  1913. 
It  appears  that  he  has  paid  $5,500  in  premiums  and  the 
remainder  necessary  to  pay  the  policy  in  full  was  ac- 
cumulated and  set  aside  wholly  out  of  earnings  made 
prior  to  1913. 

C.  has  an  annuity  of  $500  for  life.  He  bought  it 
five  years  previous  paying  $7,500.  The  company  has 
accumulated  some  earnings  on  the  principal,  a  portion 
of  which  has  already  been  taxed  as  net  earnings.  If 
the  man  dies  within  ten  years  it  may  be  said  that  all 
payments  to  him  have  been  made  out  of  principal.  If 
he  lives  to  a  great  age  his  annuity  may  exhaust  both 
principal  and  accumulations  and  the  contributions  of 
other  annuitants  will  have  to  be  drawn  upon  to  keep  up 
the  payments. 

D.  has  carried  an  ordinary  life  policy  of  $5,000  for 
50  years  and  his  net  payments  in  cash  have  aggregated 
$6,500.  There  is  also  a  sum  nearly  as  large  which  has 
come  into  the  hands  of  the  company  as  interest  incre- 
ments on  the  annual  premiums  compounded  for  50 
years.  When  the  company  pays  the  death  loss  of  $5,000 
how  shall  it  be  determined  whether  the  payment  is 
made  out  of  principal  or  interest  earnings,  either  sum 
being  more  than  sufficient  for  the  purpose? 

The  cases  cited  above  are  only  a  few  of  many  which 
might  be  adduced,  but  they  are  perhaps  sufficient  to 
show  that  any  attempt  to  differentiate  profits  or  earn- 
ings from  principal  in  respect  to  the  proceeds  of  life 
insurance  policies  paid  upon  death,  surrender  or  can- 
cellation would  involve  many  intricate  problems. 

The  general  scheme  of  the  proposed  income  tax 

34 


law  is  to  charge  individuals  and  corporations  with  the 
amount  of  gross  income  received  during  the  taxing 
year  and  to  credit  them  with  such  expenses  and  losses 
as  are  necessarily  incidental  to  the  business  of  that 
year.  The  payment  of  losses  is  a  necessary  expense  of 
the  companies  regardless  of  where  the  money  comes 
from.  If  no  losses  were  paid  there  would  soon  cease 
to  be  any  premiums.  The  losses  may  be  presumed  to 
be  paid  out  of  the  net  reserve  which  has  been  built  up 
from  the  premium  payments  and  interest  earnings  of 
former  years  and  not  from  earnings  of  the  taxing  year. 

It  will  not  do  to  say  that  all  proceeds  of  policies 
which  do  not  represent  refund  of  premium  payments 
are  earnings  which  ought  to  be  taxed  as  income.  Such 
a  theory  would  confuse  property  with  income.  The 
reserve  which  the  company  carries  and  which  it  had  on 
hand  at  the  beginning  of  the  taxing  year  is  usually 
sufficient  to  pay  all  losses  incurred  during  the  year.  If 
it  were  not,  recourse  could  be  had  to  the  "net  addition 
to  reserve  funds"  (or  more  accurately  the  addition  to 
net  reserve)  which  the  law  expressly  permits  the  com- 
pany to  deduct  from  its  gross  income. 

But,  at  this  point  the  question  may  be  asked :  Would 
not  the  same  reasoning  apply  to  dividends  ?  We  con- 
tend that  it  would  not  because  the  earnings  comprised 
in  dividends  are  the  earnings  and  profits  of  the  taxing 
year  paid  over  or  credited  to  the  policyholder  in  sub- 
stantially the  same  manner  that  dividends  are  paid  to 
stockholders  in  an  ordinary  commercial  corporation. 
The  surrender  value  of  the  policy  is  the  policyholders' 
capital  held  in  trust  for  him  by  the  company.  The 
net  annual  earnings  of  that  capital  are  income.  As 
President  Hadley  once  said :    ''Capital  is  a  static  con- 


ceptioii  independent  of  time ;  income  a  dynamic  concep- 
tion involving  the  element  of  time." 

This  conforms  to  the  theory  which  seems  to  have 
been  adopted  by  most  European  countries,  viz:  that 
gifts,  inheritances  and  proceeds  of  life  or  accident  in- 
surance policies  are  mere  accessions  to  capital  and  in 
no  sense  income.  They  lack  the  elements  of  continuity, 
regularity  and  annual  recurrency  which  are  charac- 
teristic of  income. 

Thus  the  Prussian  law  provides  (Einkommen- 
steuergesetz,  Section  7)  that  extraordinary  receipts 
from  inheritances,  gifts  or  life  insurance  shall  not  be 
treated  as  taxable  income,  but  as  accessions  to  capital. 
The  income  however,  of  gifts,  inheritances  and  life  in- 
surance are  held  taxable.  Even  a  winning  in  a  lottery 
is  held  to  be  an  addition  to  capital  and  not  income. 

In  Bavaria  the  new  law  which  went  into  effect 
January  1,  1912,  provided  that  gifts,  proceeds  of  life 
and  accident  insurance,  proceeds  of  sales  of  property, 
winnings  in  lotteries  and  other  extraordinary  and  un- 
usual receipts  should  not  be  considered  income,  but  in- 
crease of  capital.  If  however,  the  individual  makes  a 
business  of  selling  property  or  speculating  in  lotteries 
then  the  receipts  from  such  sources  lose  their  excep- 
tional and  extraordinary  character  and  are  treated  as 
income.  Similar  provisions  may  be  found  in  the  laws 
of  Austria,  Sweden,  Denmark  and  several  other  coun- 
tries and  states. 


36 


SHOULD  LIFE  INSURANCE  COMPANIES  BE  SUBJECT 
TO  THE  INCOME  TAX? 

In  regard  to  the  general  argument  that  life  insur- 
ance companies  should  be  entirely  exempted  from  the 
Federal  income  tax,  even  though  they  make  profits,  be- 
cause the  provision  for  the  future  involved  in  life  in- 
surance is  something  which  ought  to  be  encouraged, 
there  are  a  few  important  considerations  which  should 
not  be  overlooked. 

In  the  first  place  all  capital  and  earnings  are,  in  a 
sense,  provision  for  the  future,  and  a  differentiation 
in  favor  of  insurance  savings  is  favoritism  as  against 
many  other  forms  of  saving  designed  to  accomplish 
the  same  purpose. 

In  the  second  place  it  is  no  proper  function  of  taxa- 
tion to  encourage  the  good  and  suppress  the  evil.  As 
was  well  said  by  Judge  Cooley : 

''A  burden  laid  not  for  the  purpose  of  producing 
revenue,  but  in  order  to  accomplish  some  ulterior  ob- 
ject which  the  government  lacks  the  power  otherwise 
to  accomplish  comes  under  no  definition  of  the  word 
"tax"  which  is  recognized  in  public  law." 

It  is  true  that  this  principle  has  often  been  violated 
in  this  country,  as  in  the  case  of  churches,  which  are 
exempt  and  saloons,  which  often  bear  excessive  taxes ; 
but  every  departure  of  this  kind  from  the  strict  rule  of 
equality  disturbs  the  balance  of  the  system  and  results 
in  a  certain  degree  of  injustice.  For  that  reason  it  may 
be  questioned  whether  fraternal  benefit  companies, 
which  sometimes  have  considerable  reserves  at  interest, 
ought  not  to  be  required  to  pay  the  income  tax  on  their 
net  income.  The  assets  of  396  fraternal  insurance 
companies  in  1911  reached  the  very  respectable  sum 

37 


of  $148,000,000  and  the  amount  of  insurance  in  force 
was  $9,839,000,000.  The  annual  income  account  of 
such  companies  amounts  to  $130,000,000  and  it  would 
seem  to  be  more  consistent  to  tax  them  than  to  exempt 
the  mutual  companies. 

In  the  third  place  the  amount  of  income  producing 
capital  which  is  devoted  to  life  insurance  constitutes 
such  a  large  portion  of  the  wealth  of  the  nation  that 
its  exemption  must  needs  be  justified  by  reasons  of 
more  than  ordinary  cogency.  The  admitted  assets  of 
239  life  insurance  companies  in  1911  reached  the  enor- 
mous total  of  $4,163,148,290.  The  total  income  for 
the  year  was  $834,950,670  of  which  there  was  re- 
ceived in  premiums  $632,350,573  leaving  apparent  in- 
terest earnings  to  the  amount  of  $202,600,097. 

Assuming  that  these  interest  earnings  are  applied 
or  used  for  the  benefit  of  the  policyholders,  we  have 
this  situation :  a  class  of  people  who  are  far  from  being 
the  poorest  in  the  country  are  asking  to  be  exempted 
from  the  income  tax  on  a  four  billion  dollar  investment 
which  is  yielding  tw^o  hundred  million  dollars  of  inter- 
est annually  because,  forsooth,  the  investment  is  a  wise 
and  judicious  one.  One  is  tempted  to  use  the  words  of 
Gladstone  when  it  was  proposed  to  exempt  Ireland 
from  the  income  tax : 

"Let  me  remind  the  Committee  what  exemption 
means ;  it  does  not  mean  that  we  have  got  a  bottomless 
purse,  that  we  can  dispense  exemptions  to  one  man 
without  injuring  another.  No,  sir.  The  exemption 
of  one  man  means  the  extra  taxation  of  another,  and 
the  exemption  of  one  country  means  the  extra  taxation 
of  another." 

So  in  the  present  instance  the  investments  in  life 

38 


insurance  can  not  be  singled  out  for  exemption  with- 
out throwing  a  very  considerable  additional  burden 
upon  the  investments  of  every  other  kind  many  of 
which  are  equally  deserving  of  recognition. 

In  the  fourth  place  the  assumption  that  the  Federal 
income  tax  of  one  per  cent  on  the  net  earnings  of  life 
insurance  companies  will  tend  to  discourage  insurance 
in  such  companies  would  have  more  force  if  the 
amount  of  tax  which  will  be  required  from  small 
policyholders  were  not  so  insignificant.  The  relation 
between  net  earnings  and  amount  of  insurance  carried 
is,  of  course,  quite  variable  among  the  various  com- 
panies; but,  from  the  best  information  we  have  been 
able  to  obtain,  it  seems  quite  certain  that  the  actual 
amount  of  tax  which  the  companies  will  have  to  pay  to 
the  general  government  under  the  proposed  new  law 
will  not  exceed  five  cents  for  each  $1,000  of  insurance. 
No  changes  in  rates  are  likely  to  occur  by  reason  of  the 
law.  The  policyholder  will  pay  just  what  he  has  al- 
ways paid,  but  the  company,  will  recoup  the  amount  of 
the  tax  from  the  surplus  or  possibly  will  allow  a  less 
amount  as  dividend  in  succeeding  years.  In  either  case 
the  policyholder  will  not  be  made  to  feel  the  tax  though 
in  a  very  real  sense  the  tax  will  be  paid  by  him 
eventually. 

But  at  this  point  we  are  met  by  the  suggestion  that 
insurance  companies  are  already  subjected  to  an  ex- 
cessive burden  of  taxation  by  the  various  states  in 
which  they  do  business  and  therefore  ought  to  be 
exempted  from  the  income  tax.  There  is  much  force  in 
this  argument,  but  the  fault  lies  with  the  states  and  not 
with  the  government.  The  abuses  and  injustices 
which  have  grown  up  in  the  attempts  on  the  part  of 
the  states,  by  means  of  reciprocal  and  retaliatory  legis- 

39 


lation,  to  control  functions  essentially  national  in 
character,  present  a  striking  commentary  upon  the 
futility  of  all  such  efforts. 

The  ideal  plan  would  be  to  have  the  entire  super- 
vision and  taxation  of  insurance  companies  placed  in 
the  hands  of  the  Federal  government  so  that  fair  and 
uniform  treatment  could  be  accorded  to  all;  but  the 
states  will  be  very  slow  to  give  up  such  an  important 
and  productive  source  of  revenue.  The  suggestion  has 
been  made  that  the  Federal  Government  could  act  as 
an  assessing  and  collecting  agency  and  return  the  tax 
when  collected  to  the  states.  Apart  from  the  constitu- 
tional objections  to  such  a  plan  there  are  grave  difficul- 
ties which  would  arise  in  selecting  any  fair  basis  of 
apportionment. 

In  this  connection  it  should  also  be  remembered  that 
an  income  tax  rests  upon  an  entirely  different  basis 
from  the  property  tax  and  cannot  be  twisted  and 
warped  to  meet  every  inequality  and  injustice  of  local 
laws.  It  often  happens  that  real  estate  bears  more 
tha,n  its  just  burden  of  taxes  but  the  income  of  real 
estate  will  be  taxed  uniformly  without  reference  to  the 
inequalities  of  local  taxation. 

The  income  tax  is  proportioned  according  to  ability 
to  pay  and  the  measure  of  ability  to  pay  is  the  amount 
of  income.  The  property  tax  measures  the  ability  to 
pay  by  the  assessed  value  of  the  property  which  the 
individual  owns.  The  functions  and  methods  of  the  two 
taxes  are  harmonious  in  some  respects  but  divergent 
in  others  and  no  small  degree  of  careful  adjustment 
will  be  required  to  make  them  work  effectively  to- 
gether. 

40 


UNIVERSITY  OP  CALIFORNIA  LT^P  ' " 


14  DAY  USE 

RETURN  TO  DESK  FROM  WHICH  BORROWED 

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